PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS: OVERVIEW OF RELEVANT ISSUES IN TODAY’S INTERNATIONAL ECONOMY

LEONARDO F.M. CASTRO† ABSTRACT The present article analyzes the most common problems related to the Permanent Establishment (PE) concept in International Tax in current modern economy, after the booming of e-commerce, the consolidation of the globalization process, and the new attempts to update and improve such concept in double tax treaties. For that purpose, this article addresses the structure of Article 5 of the OECD Model Tax Convention and gives readers an overview of the concepts, definitions, and problems arising from each of the Article 5 paragraphs of such Model Convention. After such overview, it examines the hottest topics in today‟s international economy that are creating new PE problems, like e-commerce, attribution of profits under new Transfer Pricing methods, and the Service PE rule. Lastly, it analyzes the recent OECD discussion draft on interpretation and application of Article 5 of the OECD Model Convention and its developments to current problems. It concludes with reference to the most known issues on each PE topic, and an opinion on what should be improved in each sub-area of the Permanent Establishment article in tax treaties.

I. INTRODUCTION .................................................................... 126 II. PERMANENT ESTABLISHMENT IN DOUBLE TAX TREATIES: AN OVERVIEW ........................................................................... 128 III. THE PERMANENT ESTABLISHMENT CONCEPT ...................... 129 A. The OECD Model Code Definition of a Permanent Establishment............................................................... 129 B. “Fixed Place” Permanent Establishments .................. 130 1. The Definition of ―Fixed Place of Business‖ ....... 130 2. What Constitutes a ―Fixed Place of Business‖ ..... 132 3. Time Required to Create a Permanent Establishment ....................................................... 135 4. Problems Concerning ―Fixed Place of Business‖ .............................................................. 135 C. Project Permanent Establishments .............................. 136
† LL.M. in Taxation, Georgetown University Law Center (Graduate Tax Scholarship and Dean‟s Certificate award). International Associate at Milbank, Tweed, Hadley & McCloy LLP in New York. Email: lcastro@milbank.com.

125

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IV. V.

VI. VII.

VIII.

D. Agency Permanent Establishments .............................. 138 1. Dependent Agents and Permanent Establishments ...................................................... 138 2. Income Allocation in Agency Permanent Establishments ...................................................... 140 E. The “Carried on Through” Expression....................... 140 F. A Group Company as the Permanent Establish of another Group Company ............................................ 142 ATTRIBUTION OF PROFITS AND TRANSFER PRICING RULES . 143 A. The “Functionally Separate Entity” Approach ........... 145 B. Income and the Assumption of Risk ............................. 146 THE SERVICE PERMANENT ESTABLISHMENT RULE .............. 146 A. DIT Mumbai v. Morgan Stanley and Changes in the OECD Commentaries .................................................. 147 B. Calculating Aggregate Periods for Service PEs ......... 148 C. Current Service Permanent Establishment Language and Issues .................................................................... 149 E-COMMERCE AND PERMANENT ESTABLISHMENTS............. 150 THE OECD‘S RECENT PROPOSED CHANGES TO THE PE COMMENTARY: OCTOBER 12, 2011 DISCUSSION DRAFT .... 152 A. The “At the Disposal of” Expression .......................... 153 B. “Converted” Local Entities ......................................... 154 C. Time Requirements ...................................................... 155 D. The Presence of Foreign Enterprise Personnel .......... 155 E. The “In the Name of” Expression ............................... 156 CONCLUSION ....................................................................... 156

I. INTRODUCTION ―Permanent Establishment‖ (PE) is a tax concept that indicates a particular leve l of business activity in the Source State (i.e., the state other than the residence state of the person carrying on the business concerned). 1 The concept of PE is particularly important for Article 7 (Business Profits) of the Organisation for Economic CoOperation and Development Model Tax Convention (OECD MC). 2 Additionally, it is also relevant to various other treaty provisions (including Articles 10 [Dividends], 3
See generally OECD, COMMITTEE ON FISCAL AFFAIRS, MODEL TAX CONVENTION ON INCOME AND CAPITAL: CONDENSED VERSION, art. 7, at 26-27 (July 2010), available at http://www.keepeek.com/Digital-Asset-Management/oecd/taxation/model-tax-convention-onincome-and-on-capital-condensed-version-2010_mtc_cond-2010-en [hereinafter OECD MODEL CONVENTION].
2 3 1

See generally id. art. 7, at 26-27. See id. art. 10, ¶ 4, at 28.

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11 [Interest],4 and 15 [Employment income] 5). Nonetheless, greater importance might be reserved to Article 7 since, for purposes of interaction with such provision, Article 5 defines the threshold above which the Source State may tax business profits earned in that State by a resident of the other treaty State. 6 In the 2000 update to the OECD MC, Article 14 (Independent Personal Services)―which dealt specifically with income from professional services―was deleted.7 It employed the notion of ―fixed base‖ as a threshold for Source State taxation.8 As the precise difference between ―fixed base‖ and ―permanent establishment‖ was never fully clear, not even for some scholars, it was decided in 2000 to merge Article 14 into Article 7, 9 ending this dual treatment for individuals and companies. Since that time, the term ―business profits‖ includes i ncome from professional services and from other activities of an independent character. 10 Article 5 of the OECD MC defines in seven paragraphs the terms, conditions and requirements for a PE.11 Paragraph 1 defines the archetypal ―physical‖ PE. 12 The second paragraph provides a rather useless list of examples which are not a priori cases of physical PEs (i.e., in each instance one must check whether a given establishment meets the requirements of Article 5(1)).13 Paragraph 3 deals with ―project PEs‖—building sites and construction or installation projects.14 In paragraph 4, de minimis exceptions are provided for the PE definitions of paragraphs 1, 3 and 5.15 Paragraphs 5 and 6 define a third type of PE called an ―agency PE.‖ 16 Finally, paragraph 7 explains that a subsidiary is not by itself a PE of its parent company and vice versa.17

4 5 6 7

See id. art. 11, ¶ 4, at 29. See id. art. 15, ¶ 2(c), at 31. See generally id. art. 5, at 24-25.

See OECD, COMMITTEE ON FISCAL AFFAIRS, COMMENTARY ON ARTICLE 5 CONCERNING DEFINITION OF PERMANENT ESTABLISHMENT, ¶ 1.1, at 92 (July 2010), available at http://www.keepeek.com/Digital-Asset-Management/oecd/taxation/model-tax-convention-onincome-and-on-capital-condensed-version-2010_mtc_cond-2010-en [hereinafter COMMENTARY ON ARTICLE 5].
THE

Christoph Trzaskalik & Marion Petri, Administrative Provisions in Taxation Law, in INT‘L TAX L. 99, 166-67 (Andrea Amatucci & Christoph Trzaskalik eds., 2006).
9 10

8

COMMENTARY ON ARTICLE 5, supra note 7, ¶ 1.1, at 92. note 1, art. 3, ¶ 1(h), at 23; see also COMMENTARY

OECD MODEL CONVENTION, supra ON ARTICLE 5, supra note 7, ¶ 1.1, at 92.
11 12 13 14 15 16 17

See generally OECD MODEL CONVENTION, supra note 1, art. 5, at 24-25. Id. art. 5, ¶ 1, at 24. Id. art. 5, ¶ 2, at 24. Id. art. 5, ¶ 3, at 24. Id. art. 5, ¶ 4, at 24. Id. art. 5, ¶¶ 5-6, at 24. Id. art. 5, ¶ 7, at 24.

however. supra note 1. ¶ 1. is liable to tax therein by reason of his domicile.‖ reads as follows: For the purposes of this Convention. See generally OECD MODEL CONVENTION. II. residence.128 THE GLOBAL BUSINESS LAW REVIEW [Vol. However. 15.irs. and the points that need further analysis. hence.S. The objective of this study is to contribute to the development and improvement of the PE provision. the income generated within the State may be directly imputed to the enterprise established therein and. does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein. which defines ―residents. the term ―resident of a Contracting State‖ means any person who. requirements and relevant discussions related to the PE article and examine them to spot the trouble issues. the Source State may impose tax on income.gov/pub/irs-trty/model006. 2006 (2006). the requirements. after several decades since the concept of PE was originally created. the current wording and Commentaries remain sufficient to establish the proper allocation of taxing powers between the Source State (state of the PE) and the Residence State (state of the head office of the company itself). art. where such genuine link (residence) fails to exist. available at http://www.org/esa/ffd/ documents/DoubleTaxation. Due to the undeniable importance of the PE provision in a cross-border transaction—meaning that. a See generally UNITED NATIONS MODEL CONVENTION FOR TAX TREATIES BETWEEN DEVELOPED AND DEVELOPING COUNTRIES (1980).S.un. place of management or any other criterion of a similar nature. DEP'T OF THE TREASURY. Model Conventions)18 in order to determine whether. available at http://www. and also includes that State and any political subdivision or local authority thereof. 4.pdf [hereinafter U. PERMANENT ESTABLISHMENT IN DOUBLE TAX TREATIES: AN OVERVIEW International tax treaties to avoid double taxation (also known as ―double tax treaties‖ or just ―tax treaties‖) use residence criteria to establish the minimum nexus for taxing a person or an entity in its own territorial limits. new wording or additional attention in the Model Convention and in the Commentaries. and competitive economy is crucial for international tax purposes. under the laws of that State. art. 2:125 This article analyzes the concept of PE. The first paragraph of Article 4 of the OECD Model Convention. This term. 4. only the Residence State may tax the income —it is very important to go through all the items.pdf [hereinafter UN MODEL CONVENTION]. at 24.S. fast movement of capital and services. if there is a PE. and if there is not a PE.20 Consequently. the unclear concepts. UNITED STATES MODEL INCOME TAX CONVENTION OF NOV. conditions and different types of PEs existing in the OECD Model Convention (and mostly reflected in UN and U. at 24. . Id. MODEL CONVENTION]. U. 20 19 18 See generally id. directly subject to taxation on profits. particularly when determining whether a transnational investment or cross-border transaction is feasible or not.19 The subsistence of an effective place of management or headquarters within the jurisdictional boundaries of that State—the criteria used to determine if a company resides in a contracting state—is often considered to be a sufficient factor that demonstrates the economic and social importance inherent to the relation of sovereignty between a State and that specific subject. Its practical applicability in this new era of intangible assets.

Permanent Establishment in the Model Tax Convention .22 but also the United States Model Income Tax Convention 23). Model Conventions. 26 See Cormac Kelleher. III. the concept of PE becomes. ―tax treaties‖). Specifically under tax treaties. WITH PARTICULAR REFERENCE TO GERMAN TREATY PRACTICE 15-19 (3d ed. 2011).pdf (last visited Feb. UN and U. 2012). U. As mentioned..NET. a basic requirement to be met before any taxation on business profits may occur under a bilateral treaty based on the OECD MC..24 which helps prevent circumstances where different States would concurrently levy taxes on the same economic earnings. On the opposite side. the broad meaning of the terms used in such concepts—the fulfillment of the requirements and the facts and circumstances of each case—make it extremely complex. Stefan Schmid. UN MODEL CONVENTION. 22. the subject of permanent establishments continues to be one of the most fascinating. 1997). & Nathalie Urban eds. Holding a central role in such exercise. they are also further enhancing the risk that one of those subjects may become susceptible to overlapping taxation by more than one tax jurisdiction. BILATERAL TAX TREATY AND OECD PERSPECTIVE 187 (Ekkehart Reimer. some legal instruments. KLAUS VOGEL ON DOUBLE TAXATION CONVENTIONS: A COMMENTARY TO THE OECD.ttn-taxation. As a response. 26 It is often referred to as a legal fiction that enables one State to widen its taxation capacity over a non21 22 23 24 OECD MODEL CONVENTION.. KLAUS VOGEL ET AL. in PERMANENT ESTABLISHMENTS: A DOMESTIC TAXATION.g. important and intricate topics of international taxation. Ekkehart Reimer. difficult and debatable for taxpayers and tax authorities to precisely determine when a ―permanent establishment‖ actually exists for a certain enterprise.25 However. in itself.S. The OECD Model Code Definition of a Permanent Establishment The idea of a Permanent Establishment (PE) is inherent to treaties against double taxation (e. even though such definition is made by the OECD. whenever two or more States expand their tax capacity to a higher international degree in order to include foreign taxpayers. TTN-TAXATION. For this reason. problems and implications under current cross-border transactions and multinational business activities. assuming the form of internationally binding bilateral agreements (mainly the OECD Model Tax Convention21 and the United Nations Model Convention for Tax Treaties between Developed and Developing Countries. were created under a prenegotiated standard structure. supra note 18.2012] PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS 129 State may only tax a foreign taxpayer if it is determined that a substantial economic interest or engagement within the life of the country still exists. MODEL CONVENTION. THE PERMANENT ESTABLISHMENT CONCEPT A. it is crucial to explore its definitions. UN AND U.S. supra note 1. supra note 18. 25 . though. MODEL CONVENTIONS FOR THE AVOIDANCE OF DOUBLE TAXATION ON INCOME AND CAPITAL. Problems with Permanent Establishments 1. the existence of a PE is a minimum threshold required for a country to tax non-residents‘ business profits derived from sources in that jurisdiction where they are carrying on business. available at http://www.S.net/pdfs/prizes/CormacKelleherEssay.

32 Klaus Vogel recognizes a simple method of applying PE requirements in order to verify if a PE is present in a cross-border business. See id. supra note 1. Manual for the Negotiation of Bilateral Tax Treaties between Developed and Developing Countries ¶ 11. at 24.pdf [hereinafter UN Manual]. there is no need to determine whether there is also a PE under paragraphs 5 and 6. supra note 1. since in the first analysis these last types of PE would already be covered.html (last visited Feb. the term ‗permanent establishment‘ means a fixed place of business through which the business of an enterprise is wholly or partly carried on. B. 7.. or through the acts in the Contracting State of individual employees with the non-resident entity. 5. 28 The OECD Model Tax Convention is the framework typically used by developed countries when negotiating tax treaties. art. available at http://www. 22.33 After that analysis.org/intradoc/groups/public/documents/un/unpan008579. ¶ 1.27 Essentially. at 24-25. at 3. art. ¶ 5. art. 33 34 VOGEL.130 THE GLOBAL BUSINESS LAW REVIEW [Vol. or a dependent agent. available at http://unpan1. supra note 27. supra note 24. a country may not tax business profits of an enterprise unless that enterprise has a PE in that State. Thus. ¶ 1. 5. ¶¶ 1. which involves the an individual or company to act on behalf of the non-resident entity in the Contracting State. at 281. Aff. at 26. there are two general types of PEs in the OECD MC: (1) the fixed place of business PE30 and (2) the agency PE.com/ accounting/ 3605358-1. Commissioner of Taxation.allbusiness. the PE definition determines the right of a contracting State to tax the profits of an enterprise of the other contracting State.31 The relationship between Articles 5(1) and 5(5) shows that a Contracting State obtains taxing rights over a non-resident entity only if that enterprise first has a fixed place of business. such as an office or store. ¶ 1. 5. “Fixed Place” Permanent Establishments 1. 28 29 30 31 32 OECD MODEL CONVENTION. 2012). In McDermott Industries (Aust) Pty Ltd. supra note 1. art. basically by verifying if there is a PE under paragraphs 1 or 3. 2:125 resident legal entity which would not otherwise be normally considered subject to an income tax in that State. v.un. at 3 (2003). at 3. ALLBUSINESS. Kersch. at 24. The Definition of ―Fixed Place of Business‖ A fixed place of business PE exists where an enterprise carries on business in a country through a fixed location. & Soc.N. its definition codified in Article 5(1) of the OECD Model Convention. either through management of assets of the non-resident entity located in the Contracting State. Comments on Definition of Permanent Establishment in the OECD Model Tax Convention. art. See generally OECD MODEL CONVENTION. 29 According to Article 5 of the OECD MC. See OECD MODEL CONVENTION.‖34 27 See U. UN MANUAL. Dep‘t of Eco.COM. 5. at 25. and where no further connection to the territory is provided. 5. according to Article 7 of the OECD Model Convention. See also Guy A. which provides that ―[f]or the purposes of this Convention. supra note 1. ¶ 11. it was argued that subsequent provisions should . OECD MODEL CONVENTION.

at 90. supra note 7. (2) the place of business must be of a ―fixed‖ nature (geographical and temporal permanence). Problems with Permanent Establishments: Problems in Determining Permanent Establishment on the Basis of Article 5(1) OECD MC 2. 393 (2007). TAX‘N 389. 2012). therefore. 41 For that purpose. 38 37 Rafffaele Russo & Edoardo Pedrazzini. a ―place of business‖ shall include all physical objects.43 be construed having regard to the general definition clause since they elaborate and elucidate (but not ―vastly‖ expand) the concept of substantial business expressed in the general definition provision of Permanent Establishment. PUBLIC DISCUSSION DRAFT: ARE THE CURRENT TREATY RULES FOR TAXING BUSINESS PROFITS APPROPRIATE FOR E-COMMERCE?. 40 However. 26.1. art. 2003). McDermott Industries (Aust) Pty Ltd v. supra note 36.pdf [hereinafter CURRENT TREATY RULES]. notably: (1) the existence of a ―place of business‖ at the disposal of the enterprise. 5.org/dataoecd/2/38/20655083. as may be the case with floating-restaurants or ship-museums. at 2. ¶ 8. supra note 7. ¶ 57.‖ 42 This may be pertinent where such properties are connected to a certain site. See also Arvid A Skaar. Id. at 7 (Nov. [2005] FCAFC 67.NET. 71. ¶ 2. at 93. . http://www.39 Regarding such matter. Albin. at 96-97. at 13 (Amsterdam 2005). 47 EUR.pdf (last visited Jan. COMMENTARY ON ARTICLE 5. at 10. equipment and accessories used by the taxpayer. supra note 7. a tangible element. a specific situs. However. supra note 7. See also COMMENTARY ON ARTICLE 5. such approach was posterior rejected by the Australian Full Federal Court. ¶ 1. IBFD.. tangible assets themselves can be regarded as ―places. at 92. 38 Therefore. 52. TAX REV. and (3) th e enterprise being carried on is required to be ―carried on through‖ the fixed place of business. 36 The term ―fixed place‖ seems to redirect the concept towards the indispensable existence of a physical location where the business is situated.ttn-taxation. 35 36 UN MODEL CONVENTION. 31. 39 See COMMENTARY ON ARTICLE 5. which can be translated into an effective geographical requirement. ¶ 2. supra note 18. http://www. Tiiu Albin. See also Andrew Hamad.37 In spite of the fact that the OECD MC does not have a definition of the term ―place. 62 (2006).net/pdfs/prizes/TiiuAlbinEssay. FOR TAX POL‘Y AND ADMIN. Rationalising the “Permanent Establishment. at 94. including the premises. it demands. ¶ 12. Commissioner of Taxation (2005) 142 FCR 134.2012] PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS 131 The definition put forward in the UN Model Convention is essentially similar to the one above. 41 42 43 40 See COMMENTARY ON ARTICLE 5. Permanent Establishments under Italian Tax Law: An Overview.‖ the Commentary proposes that attention should be paid to the tangible assets used for carrying on the business. ¶ 4. the Italian tax authorities have concluded that a Swiss company maintaining a piece of railway and a railway station in Italy had a PE under the Italian domestic laws.oecd. that are necessary for carrying on a businesses with a certain degree of permanence.” 35 AUSTRAL. Commentary on Article 5 of the Model Treaty: The Concept of Permanent Establishment . TTN-TAXATION. ¶ 5.35 This apparently relatively straightforward definition encapsulates three requirements in order for a PE to be present. See OECD CTR. no physical attachment to the soil is absolutely necessary.

including: (a) a place of management. ACIT [2008] 122 TTJ 655 (Del). What Constitutes a ―Fixed Place of Business‖ [Vol. Hence. available at http://www. supra note 1. supra note 39. at 286. if a taxpayer plans to exercise its operating activities through the fixed place of business for an indefinite period of time. .44 The provision of these examples reinforces the belief that a physical facility is required in order for a PE to be present. ACIT.kpmg. See review of Fugro Engineering. Hans Pijl.com/Digital-Asset-Management/oecd/taxation/model-taxconvention-on-income-and-on-capital-condensed-version-2010_mtc_cond-2010-en [hereinafter POSITIONS ON ARTICLE 5]. at 19. 5. 46 Unexpectedly.50 The length of time a non-resident has been operating in a contracting state is generally accepted as being irrelevant. available at http://www. 2011). ¶ 25. a non-OECD Member State. FOR INT‘L FISCAL DOCUMENTATION 554. 29. VOGEL. art. KPMG. 47 48 Fugro Engineering B. at 437 (2010). and (f) a mine. supra note 24. Business Connection and Permanent Establishment. ¶ 2. The Concept of Permanent Establishment and the Proposed Changes to the OECD Commentary with Special Reference to Dutch Case Law. Article 5(2) of the OECD MC sets forth a positive list (though not exhaustive) of what a permanent establishment actually consists of. 45 In this sense. (b) a branch.47 the Indian court concluded that a company engaged in carrying out activities onboard an Indian vessel belonging to three different clients would still give rise to the existence of a PE. in Fugro Engineers BV v. COMMITTEE ON FISCAL AFFAIRS.132 THE GLOBAL BUSINESS LAW REVIEW 2. 555 (2002). a PE 44 45 46 OECD MODEL CONVENTION. 56 BULL.com/IN/en/WhatWeDo/Tax/FlashNews/KPMG-Flash-News-GILMauritius-Holdings-Ltd. an oil or gas well. NON-OECD‘S ECONOMIES‘ POSITIONS ON THE OECD MODEL TAX CONVENTION.COM (Sept. even if there is no commercial coherence between different places where the business by a nonresident is carried on. 2:125 In order to complement the general definition. 49 50 See Skaar. (e) a workshop. a quarry or any other place of extraction of natural resources. India. v. the distinction between ―temporary‖ and ―permanent‖ is made based on the intention of the non-resident (a subjective factor). at 24. POSITIONS ON ARTICLE 5 (PERMANENT ESTABLISHMENT) AND ITS COMMENTARY. the doubt that remains is whether the expression ―fixed place‖ should be understood as envisaging the feasibility of locating.keepeek. identifying or pointing out a certain place which is stationary and not moving. this is true even where the taxpayer‘s activities are dispersed among the district. 49 The Dutch Supreme Court confirmed such view by stating that the mobility of a fixed place of business (in the case. a PE is still established. (d) a factory. See Har Govind. 190. it should be apparent whether a physical presence exists or not. Accordingly. In the majority of cases. a circus tent) did not prevent it from being treated as a PE.pdf.V. provided there is a sufficient nexus with a specific geographical point. 7 ASIA-PACIFIC TAX BULL. 195 (2001). (c) an office. has the position that. any geographical area that commercially or economically constitutes an entity may be considered a fixed place of business. See OECD.48 According to Arvid Skaar.

paragraph 4 of the same article contains a list of what does not constitute a PE under the Model Convention. the usage has become constant. due to the fact that the examples set out in Article 5(2) hanker to an era comprised of manufacturing and retailing businesses. This happens when a taxpayer wants to use a place of business for a short period. as from the first day the enterprise was carried out. oil wells. for the enterprise. See Kelleher. at 2. 5. and the work is considered to be taking place in a particular geographical location. for the enterprise. supra note 7. making it difficult to determine a single place of business. . art.51 Another possible PE existence can occur even when the taxpayer does not intend to have a permanent place of business in the Source State. display or delivery. supra note 26. realized. display or delivery of goods or merchandise belonging to the enterprise. OECD MODEL CONVENTION. giving rise to the existence of only one. The examples provided in Article 5(2) refer to mines. The list mainly covers any activity that holds a mere preparatory or accessorial character to the main business activity. the concept of a fixed place of business is not in keeping with modern businesses such as those in the service industry. and similar business activities. 54 However. ¶ 6. e) the maintenance of a fixed place of business solely for the purpose of carrying on.53 As a general rule. PE. supra note 39. it is largely held that mining over a such an area should constitute a single place of business. f) the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e). If this is the case. not multiple. in fact. 55 In addition to the general definition of PE stated in Article 5(1).3. ¶ 2. or development of intangible products (discussed subsequently).2012] PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS 133 would be regarded as existing in the Source State regardless of whether its intentions were not. c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise. and a PE will be considered to have been established retroactively. See COMMENTARY ON ARTICLE 5. at 96.52 It should also be pointed out that. d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information. provided that the overall activity of the fixed place of business 51 52 53 54 55 Skaar. b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage. these enterprises often span a large geographic area. ecommerce. at 24. the subjective inquiry is irrelevant. supra note 1. but for objective reasons. See id. The excluded activities mentioned in Article 5(4) include: a) [T]he use of facilities solely for the purpose of storage. any other activity of a preparatory or auxiliary character. at 34.

Richard G.5. for example. it can be understood as occurring when the taxpayer has the power or liberty to control the place and. as mentioned by several OECD Commentary examples. the material presence of the non-resident is also necessary. it is hard to determine if there is a place of business when the facilities are not at the disposal of the enterprise. See Kelleher. pointing out that even illegal presence may constitute a PE. 308 (1992).. ¶ 4. the sales staff of the non-resident entity concludes contracts at the offices of its customers. This is likely to occur where. Philip Morris GmbH. See Ministry of Finance (Tax Office) v. 5. at 93. Tremblay. an example of a narrow—and more uncommon—interpretation is found in the Austrian Treaty for the Prevention of 56 57 58 OECD MODEL CONVENTION. hence. 903 (Italy 2002) (holding that ―substance over form‖ was considered one of the five principles applicable to the Permanent Establishment definition). factual right to use) and the like are not prerequisites since the actual control over a place is not sufficient to satisfy the disposition requirement.58 Additionally. since the substance-over-form approach is often adopted according to evidence from facts and circumstances. at 25. Id. supra note 7. 2:125 resulting from this combination is of a preparatory or auxiliary character.134 THE GLOBAL BUSINESS LAW REVIEW [Vol. art. formal right to use acquired by law. ¶¶ 4. Permanent Establishments in Canada.e. 2 J. a place of business means any location used to carry on the activities of the enterprise. 4 INT'L TAX L. there [is] no permanent establishment in Canada despite the fact that a company related to the nonresident [makes] an office in Canada available to the nonresident. As to the meaning of the term ―disposition. supra note 26.e. . 62 COMMENTARY ON ARTICLE 5. supra note 7.‖ as extracted from the OECD Commentary. deposit. implicit authorization (i. commercial or residential lease. INT'L TAX 305. at 1. supra note 1. REP. the right to determine the conditions according to its needs.‖61 For this reason. 60 The Supreme Court of Canada has held that ―where there [is] no person in the office with capacity to contract on behalf of the non-resident and the conduct and control originated outside Canada. ¶ 4. although it is not always enough. 59 60 61 COMMENTARY ON ARTICLE 5. the OECD Commentary is clear in confirming that there is no need for formal legal entitlement.56 Generally. ¶ 4. In this sense.62 Conversely.1. contract or other lawful formalized agreement. and it is possible for a place of business to exist without the presence of premises or facilities.59 For this reason.1. pledge or other relationship).57 Interestingly. whether in the form of ownership. it is not necessary to have a formal legal entitlement to usage of the premises or facilities (i. though such facilities are not necessarily used exclusively by the business.2-4.. at 93. at 93-94.

Time Required to Create a Permanent Establishment Domestic courts diverge when it comes to determining the minimum period of time needed to establish a PE. POSITIONS ON ARTICLE 5.65 Alternatively. the difficulty concerning the general definition of a ―permanent establishment‖ is that the OECD Convention does not define ―fixed place of business.worldwide-tax. at 36.asp (last visited Feb. 69 Benjamin Hoffart. at 127. The Future of Taxing Business Profits. v. 106. 70 Id. give rise to a PE. the term ―fixed place of business‖ has been applied according to legal doctrine. supra note 48. 2012). PROP. mostly on a case-by-case analysis (for instance. in TAX TREATY POL‘Y & DEV. supra note 50. 1959).‖ 66 Nonetheless. including Germany and the United States. Permanent Establishment in the Digital Age: Improving and Stimulating Debate through an Access to Markets Proxy Approach . isolated activities will not. any auxiliary work or any other activity in connection with a building site or construction or installation project lasting more than six months. 6 NW.COM. 70 but still varies considerably among countries worldwide. if such activities or work also last more than six months. supra note 36. For more information on whether isolated activities could be regarded as continuous activities in the U.C. 894 (1960).68 4. since they lack the criterions of regularity. at 10-11 (citing Dietmar Herbrich. In Belgium. courts. J. for Dutch general practice purposes.63 under which the accessibility of a key or an office desk is sufficient. supra note 39. For instance. 34 T. at 557.2d 320 (6th Cir. continuity and minimum time period for a business enterprise to have a genuine link or economical connection to the Source State. exceptions may occur. in Portugal. ¶ 3 (2007). the Tribunal of Ghent decided in 2003 that the material ―fixed place‖ need not necessarily be associated with a personal ―permanent 63 Austria is a signatory to a Treaty for the Prevention of Double Taxation of which there are 83 signatories. available at http://www. . consulting.64 3.‖ which is the elementary point in determining whether a non resident‘s activities in a Source State are sufficient to create a permanent establishment.2012] PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS 135 Double Taxation. depending on the nature of the activity. for instance. generally. Problems Concerning ―Fixed Place of Business‖ As demonstrated in this topic. an enterprise may be treated as having a permanent establishment if it ―carries on an activity consisting of planning. Comm'r. a daily sale like milk cannot be compared to sales of a sugar factory). Skaar. Ltd. and the OECD Commentary since its origination. supervising. 265 F. a six-month period is regarded as satisfactory to create a PE for taxation determinations. see also De Amodio v.S. see generally Consolidated Premium Iron Ores. Albin. 336 (Markus Stefaner & Mario Züger eds. ¶ 64.69 Thus. 2005)). TECH & INTELL. WORLDWIDE-TAX. case law. Commissioner. 67 Even so.com/ austria/aus_double.. 65 66 67 68 64 See Pijl. See Austria Double Taxation Prevention Treaties. 20.

com/view/en_BE/be/ insights/newsletters/tax-quarterly/issue-39-january2009/544fddf413246210VgnVCM200000bb42f00aRCRD. a business activity) which fell within the framework of a ―permanent establishment‖ even though there was no representation to contract.mruni. the definition of a paragraph 1 PE was broadened to comprise also the paragraph 3 definition of a ―Project PE. 4. but without considerable harmonization until today. available at http://www. varying from country to country. Part 1]. TAX Q.htm.1. 72 Under Belgian domestic law.136 THE GLOBAL BUSINESS LAW REVIEW [Vol. 189-93 (2005).73 The presence of a PE may only be significant where head office expenses are attributed to the lease under Article 7 of the OECD. supra note 1.htm [hereinafter Cauwenbergh & Claes. See generally Patrick Cauwenbergh & André Claes.e. Permanent Establishment. Hans Pijl. 2003. http://www. no. a Belgian business enterprise is no longer required to tax foreign real estate owners leasing Belgian property directly to Belgian persons or enterprises.. 74 Nevertheless. (Jan. see also Patrick Cauwenbergh & André Claes. Outline of Article 5 of the OECD Model Convention. Part 1.. Definition of „Permanent Establishment‟: Part 1. The Relationship between Article 5.com/view/en_BE/be/insights/newsletters/tax-quarterly/issue40may2010/057a7315d0278210VgnVCM200000bb42f00aRCRD. ¶ 5. Id.‖76 There is disagreement whether in view of the text of Article 5 the changed Commentary has the intended effect. art. See João Sérgio Ribeiro. Project Permanent Establishments Various scholars have taken the position that the PE defined in Article 5(3) (what is known as a ―Project PE‖) is different from the physical PE in Article 5(1). at 24. 2010). available at http://www. 1(115) JURISPRUDENCIJA 295. C. RECHTSKUNDIG WEEKBLAD [RW] 2003 (Belg.deloitte. supra note 7. 78 This view of the fixed requirement and permanence consubstantiates into an effective time requirement. ¶ 1. 33 INT‘L TAX REV. Paragraphs 1 and 3 of the OECD Model Convention.). 5. at 94.‖71 In that case. Com. the notion of PEs still leads to different interpretations among countries and subsequently continues to cause confusion in treaty interpretation. at 4. Apr. A ―permanence Hof van Beroep [HvB] [Court of Appeal] Antwerpen. a Luxemburg company engaged in the management of a real estate asset was considered to have a professionally profitable activity (i. (May 2010). 237. No. 39 DELOITTE BELG. 5/238. Definition of „Permanent Establishment‟: Part 2. 72 73 74 75 71 Cauwenbergh & Claes. 75 In the 2003 update to the Commentary.eu/en/mokslo_ darbai/jurisprudencija/archyvas/?l=75234. A wide range of jurisprudence can be found explaining the terminology within Article 5 of the Model Treaty. 40 DELOITTE BELG. supra note 71.77 The ―fixed‖ requirement mentioned in Article 5(1) connotes that a certain quality of permanence is also mandatory.DTC. 2:125 establishment. published in FISCOLOOG 2003. Permanent Establishment. Id. .deloitte. no. 300 (2009). TAX Q. 78 OECD MODEL CONVENTION. 1. 76 77 See COMMENTARY ON ARTICLE 5.

¶ 19.g. 5. art.81 The twelve-month duration will apply to each individual project. according to the OECD Commentary. ¶ 19. See also Kelleher. since the time spent by the sub-contractors is taken into account in determining if the principal has a PE. Id. contractors may attempt to subcontract portions of the project to third parties.2012] PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS 137 test‖ is often conducted through a contrario sensu judgment method: a place of business is considered to be permanent ―if it is not of a merely temporary nature. India. 82 Once work commences. ¶ 6. 85 Despite subcontracting parts of the work. at 100. supra note 26. 83 COMMENTARY ON ARTICLE 5. ¶ 18.84 In order to evade the twelve-month standard. supra note 18. Morocco. OECD MODEL CONVENTION. at 3. even due to factors beyond contractors‘ control (e. 88 89 COMMENTARY ON ARTICLE 5. stating that ―a series of consecutive short-term sites or projects operated by a contractor would give rise to the existence of a permanent establishment in the country concerned. COMMENTARY ON ARTICLE 5. Difficulties may arise in determining if a project is within the twelve-month timescale. UN MODEL CONVENTION.‖ POSITIONS ON ARTICLE 5. supra note 7. See also Kelleher. ¶ 19.‖79 Nevertheless. wherever in presence of a ― building site or construction or installation project. ¶ 3. the project is considered to be enduring until activity ceases. at 95. supra note 26. supra note 48.83 It shall be stressed that the project term will not be considered to cease where there are periods of temporary abatements. 86 The twelve-month test applies to each individual project or situs.. supra note 7. Id. at 437. at 25. 84 85 86 87 COMMENTARY ON ARTICLE 5. supra note 1. at 100. weather conditions. ¶ 18. the principal contractor may still have a foreign PE. ¶ 19. work spent on projects unrelated to the one being examined is not taken into account. ¶ 18. 80 or six months in the UN Model Convention. 88 However.89 Because entities often attempted to skirt the 79 80 81 82 COMMENTARY ON ARTICLE 5. the OECD and UN Model Conventions provide further enlightenment on this matter by ruling that. third party agencies or industrial disputes). given that it may be challenging to identify when the project commenced. It is understood that the term starts when the contractor begins his or her preparatory work in the foreign jurisdiction.‖ a PE is only constituted if any of the previous figures lasts for more than twelve months in the OECD MC. at 10. . at 100. at 100. at 100. at 100. supra note 7. and Vietnam have voiced their reservations about the 12-month test applying to each individual site where a project is held. ¶ 20. a project may be considered as a single endeavor because of its commercial and geographical links. at 100. 87 In establishing the length of each project. supra note 7. at 3. Id. See id. regardless of the number of contracts involved. supra note 7.

It is relevant to state that Article 5(3) of the OECD MC is one of the most modified articles when Contracting States initiate tax treaty negotiations. ¶ 6. supra note 1. a PE can still arise. Thus. the OECD twelve-month test comes with its own difficulties. for instance. especially considering the duration of time in order to configure a construction site or building PE. at 105. ¶ 32. . Agency Permanent Establishments An agency PE exists under the OECD MC Article 5(5) when an agent acts on behalf of a foreign principal and habitually exercises authority to conclude contracts in the name of the principal. ¶ 10. art. COMMENTARY ON ARTICLE 5. which can be reduced from twelve to as little as three months. .91 Actually. leading to unfair taxation standards. D. this operation by taxpayers is no longer effective. supra note 26. 2:125 twelve-month provision by compartmentalizing contracts amongst multiple connected parties. . at 97. in a Contracting State an authority to conclude contracts in the name of the enterprise. 1. an enterprise should be considered to have a PE in a foreign jurisdiction where it is carrying on business through an agent who is acting in the ordinary course of business. this does not seem to be the spirit of the tax treaties. it may also be either an individual or a corporation. 5.93 since in this case it is obvious that there is no binding contract between the foreign company (non-resident) and the independent agent (resident). earthquakes. This ―acting in the ordinary course of their 90 91 92 See id. strikes and others. at 25. it would be impossible for the foreign company to have a PE regarding the enterprise of a third party (the independent agent). ¶ 5. Dependent Agents and Permanent Establishments The type of agent that can create a PE on behalf of an enterprise is referred to as a ―dependent agent. art. It has been noted that because there is no provision for temporary absences due to weather. depending on the treaty. . . See Kelleher.‖94 A dependent agent can be classified as such whether or not the agent is an employee of the enterprise. OECD MODEL CONVENTION. 92 The OECD MC provides an exception for an independent agent acting in the ordinary course of its business. in relevant part: [W]here a person . Id.95 In other words. it would be advisable to have an exception for the twelve-month provision to cover such abnormal circumstances. supra note 7.138 THE GLOBAL BUSINESS LAW REVIEW [Vol. and habitually exercises. While it may be difficult to monitor and enforce this. Article 5(5) states. at 3. such as involuntary interruption of construction work due to floods. Id. currency or monetary crisis.90 Though seemingly simple. is acting on behalf of an enterprise and has. . at 25. 5. that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise . 93 94 95 Id.

2012] PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS 139 business‖ test has been the source of much uncertainty and criticism. art.ie/en/practitioner/law/double/japan. general commission agent or any other agent of an independent status are not considered a permanent establishment in a Contracting State. Sprague & Rachel Hersey. many treaties adopt the definitions stated above in determining whether an agency results in a PE situation. 1974. in and of itself. supra note 1. and that ―persons whose only role is to receive and acknowledge a customer‘s acceptance of a foreign enterprise‘s offer to sell a product or service on terms and conditions pre -set by the foreign principal should not be treated as a person with contract concluding authority within the meaning of Article 5(5).-Japan. available at http://www. 5. supra note 7.‖ Gary D. habitually exercised in the Source State.100 Moreover. TAX‘N 151.html. e.au/au/journals/JATax/1998/12. REV. to negotiate and conclude contracts on behalf of the foreign organization.99 Consequently.html#Heading170. at 4. certain treaties provide alternatives which allow for negotiations and conclusion of contracts related to the agency PE.. § 3. 299. ¶ 33. OECD MODEL CONVENTION. under Article 5(5). much still rests on the legal system in each jurisdiction. 102 In general.edu. Convention between Ireland and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income. supra note 26. at 25.1 (1998). 328-29 (2003). 102 It has also been suggested that the OECD Article 5 Commentary be refined to confirm that dependent agents in agency PEs use business judgment in the formation of the contract.‖ 101 Perhaps paragraph 32 of the Commentary on Article 5(5) should be clarified to include an express mention that the mere attendance at or participation by a person acting on behalf of an enterprise in business negotiations of the enterprise will not. supra note 1. . Jan.103 96 See Kelleher. Id. COMMENTARY ON ARTICLE 5. art. OECD MODEL CONVENTION. L. in and of itself. available at http://www.g. in order for an agent‘s activity to give rise to a PE. on their own specific wording to clarify future issues among the Contracting States. 5.austlii. Some Aspects of a Permanent Establishment in Australia. 98 Merely being present at the negotiations cannot. the agent is required to have sufficient authority. at 25. the existence of the authority to conclude contracts should be the determining factor in whether an agency PE is found to exist. 1(2) J.97 Also. 103 See.9. Ir. Permanent Establishments and Internet-Enabled Enterprises: The Physical Presence and Contract Concluding Dependent Agent Tests. be sufficient justification for finding a PE under paragraph 5. OF AUSTL. 96 While the OECD Commentary endeavors to illuminate the situation. it is expressly stated in Article 5(6) that a broker. 97 98 99 100 101 See Kelleher.revenue. at 106. comprise sufficient evidence that the person has or habitually exercises an authority to conclude contracts in the name of the enterprise. 38 GA. 18. However. at 4. See generally Tan How Teck. ―p rovided that such persons are acting in the ordinary course of their business. ¶ 5. supra note 26. ¶ 6.

10-12. at 26-27. only income derived from active trade or business can be the basis for the existence of a PE (i. art.‖ E.2. supra note 7. 7. 7. 108 However. See generally id.‖107 Thus. art.106 However. such as dividends. ¶ 2. all other types of income (especially passive income.105 It is therefore preferable to refer to activities as carried on through an ―agency PE‖ rather than through an ―agent. and not only once. at 28-30. ¶ 2. it depends on whether the agent‘s fee is taxable by the source country under the pertinent treaty rules. the fee earned by him as an agent is taxed to him as part of his worldwide income. Thus. ¶¶ 2-4. in order for a place of business to constitute a PE. at 24. supra note 1.110 Consequently. In this sense. The “Carried on Through” Expression It is necessary to reaffirm that the concept of PE under Article 5(1) requires that the business activity is carried on through the fixed place. 106 107 108 109 110 111 Id. it is necessary for the enterprise to carry on its business activities wholly or partly through it. the agency PE is very imprecise due to the fact you have to determine which part of the whole business price is attributable to the agent. and an independent contractor sells the apartment for a higher amount. the income attributable to that agency PE will suffer modifications. it is not required that the entire business be conducted by means of the fixed place of business. considering the cost of the real estate and the sale price and the commission received. arts. when treating the arm‘s -length price of an agent. but that only a fraction has been effectively carried on that way. ¶ 1. If the agent is a resident of that state. at 26. if the agent receives a commission for selling property in the host State.140 THE GLOBAL BUSINESS LAW REVIEW [Vol. See generally OECD MODEL CONVENTION.. since the PE shall be treated as a separate entity for purposes of allocation of profits. sometimes this is not an easy task. 109 This conclusion is extracted from ―carry on. 7. 5. ¶ 6. at 92-93. at 26-27. supra note 1. supra note 1. interests and royalties) fall under other articles of the OECD MC and cannot be attributed to the PE. See id. . See generally OECD MODEL CONVENTION.111 104 105 See OECD MODEL CONVENTION. only income that would fall within OECD MC Article 7 scope can be included as PE income or active business income).e. If the agent is a non-resident. 104 For example. 2:125 2. arts. art. See generally COMMENTARY ON ARTICLE 5. it is considered necessary for the activity to be carried on on a regular basis. 31. this condition is met by satisfying what is known as the ―business activities test. 15. Income Allocation in Agency Permanent Establishments Income allocation is the problem of an agency PE. It should be clearly understood that whether there is or is not an agency PE is a matter of tax liability of the principal (on whose behalf the agent acts) and not of the agent himself. The agent‘s tax liability in the State where he acts as an agent depends on the agent‘s residence. at 95-96.‖ a phrase which strongly suggests continuity and regularity. Id. The activity is not required to be of a permanent nature.

art. (1946).2012] PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS 141 It is relevant to mention that the OECD Model Treaty 2008 version is the one that included the term ―through. Finally. 115 The word ―through‖ in the definition of permanent establishments charges that activities of the business must take place in the fixed place. the OECD‘s new concept of a place of business. art.M.‖ often leads to the existence of a PE even if the activities have mainly or nothing but expenditures. available at http://faculty.‖113 This definition differs from its forerunner 1963 version. regarding whether a road may constitute a permanent establishment for an See generally OECD. at 13. . most links between the fixed place and business activity will fulfill the requirements of permanent establishments. recent discussions are making this requirement more difficult to be duly and unanimously answered. Each jurisdiction will have its own criteria for determining what constitutes the ―carrying on‖ of business in the region.II. available at http://www. 113 114 112 Id. MODEL TAX CONVENTION ON INCOME AND CAPITAL: DRAFT DOUBLE TAXATION CONVENTION ON INCOME AND CAPITAL. which provided that a PE was: ―. such as those of Mexico and London. 52. a fixed place of business in which the business or enterprise is wholly or partly carried on.edu/tad/Documents/Tax_treaties/oecd_1963. at 13. See id.‖ 112 As previously indicated. See id. COMMITTEE ON FISCAL AFFAIRS. 119 proffered that establishments used merely for the purposes of services having no precise link with the profits generated by the business entity should not entitle the site State to retain taxation rights.1946. Rationalising the “Permanent Establishment. .120 However. 116 Therefore. 118 Alternatively. previous Model Conventions. Official No. London and Mexico Model Tax Conventions: Commentary and Text. ¶ 1. together with the domestic definition o f ―carried on.law. making it theoretically possible for the definition to apply to any situation where business activities are carried on at a particular location that could be used by the organization.wayne. a fixed place of business through which the business of an enterprise is wholly or partly carried on. One such example is raised by Professor Kees van Raad. at 3. 118 Andrew Hamad. 5. MODEL TAX CONVENTION ON INCOME AND CAPITAL: CONDENSED VERSION (July 2008). COMMITTEE ON FISCAL AFFAIRS. OECD. Fiscal Committee.‖ 114 The 2008 revised definition results in a wider application of the concept of a PE. supra note 36. 120 119 Albin. supra note 36. . . See generally League of Nations.pdf (emphasis added). . For that reason. ¶ 1. at 3 (1963). 115 116 117 See Albin.keepeek.” 35 AUSTN. the determination of whether the foreign entity business is being carried on through a PE will be made by reference to the domestic laws of the foreign jurisdiction. TAX REV.: C. the 2008 definition of PE is: ―.117 Apparently. this is not the current scenario created by the OECD and UN definitions of PE.com/Digital-Asset-Management/oecd/taxation/model-tax-convention-onincome-and-on-capital-condensed-version-2008_mtc_cond-2008-en [hereinafter OECD 2008 MODEL CONVENTION] (emphasis added).A. 5.88. at 24. 66 (2006).

states: The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State. it is specified that no PE exists where a group company provides services to another group company. each company is a separate legal entity.142 THE GLOBAL BUSINESS LAW REVIEW [Vol. 125 In this sense. art. The 2005 OECD Model Convention and Commentary. shall not of itself constitute either company a permanent establishment of the other. the last paragraph of Article 5.124 F. ¶ 41. . 128 129 See id.1. supra note 1. a company resident in one state cannot be a PE of a company resident in another state simply because the latter controls or is controlled by the former. thus. OECD MODEL CONVENTION. See id. 128 As the OECD felt that the Italian Supreme Court had misinterpreted the PE notion in the Italian Philip Morris decision. 129 it clarified the existing Commentary by making some additions to the Article 5 Commentary. 122 To verify if there is a PE in this case. 122 123 124 125 126 127 See id.126 The 2005 changes to the Commentary clarify that. ¶ 5. OECD.oecd. A Group Company as the Permanent Establish of another Group Company Paragraph 7. at 25. at 6 (Mar. art. or which carries on business in that other State (whether through a permanent establishment or otherwise). at 6.123 According to the author. ¶ 42. stressing that one must look 121 See generally Kees Van Raad. while using its own personnel. if one company can be considered a dependent agent of the other company under Article 5(5). TAX‘N 560 (2005) (providing a brief discussion of the 2002 Italian Philip Morris decision). ¶ 7. 5. at 25. the main question is whether the road is at the disposal of the trucking company. See id.pdf [hereinafter OECD 2005 UPDATE]. Philip Morris GmbH. the existence of a PE under paragraphs 1 or 5 must be ascertained separately for each company of the group and not for the group as a whole. See also Raffaele Russo. 15. 5. as part of its business carried on on its premises that are not those of the recipient of the services. However. 127 In addition. available at http://www. 2:125 internationally operating trucking company. 12 EUR.121 The same issue arises with regard to railroad companies that make use of tracks in other countries and also for internationally operating bus companies. New Sources of Tax Revenue for (Rail)road Transit Countries? (April 2011) (unpublished paper) (on file with author). THE 2005 UPDATE TO THE MODEL TAX CONVENTION: PUBLIC DISCUSSION DRAFT. See id. then an agency PE will exist. 903 (Italy 2002). 2004). the trucking company has the road at its disposal and. the answer is positive. 4 INT'L TAX L.org/dataoecd/54/24/34576874. REP. in the case of a group of companies. it makes rise to a railroad PE. Ministry of Finance (Tax Office of Italy) v.

Subject to the provisions of paragraph 3. ¶ 42. 134 The economic benefits the latter company receives from such service or manufacturing does not imply the existence of a PE. art. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. it is indubitable that Article 7 (Business Profits) of the OECD Model Convention will be brought up as well.1. at 6. 130 Modifications to the Commentary include the following: 1. at 6. ¶ 41.131 2. at 5. If one multinational group company provides services to or manufactures products for another group company on its own premises and with its own personnel. supra note 1. there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment.‖ reads as follows: 1. habitually carrying on business in the name of the parent. See generally OECD MODEL CONVENTION.136 The Commentary on Article 7 states the generally accepted principle of 130 131 132 133 134 135 136 OECD 2005 UPDATE. Determining whether a PE exists will be accomplished for each company of the group individually.2012] PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS 143 separately at each company of the group and not at the group as a whole. ATTRIBUTION OF PROFITS AND TRANSFER PRICING RULES When the rule of Permanent Establishment is mentioned. Id. ¶ 33. If the enterprise carries on business as aforesaid. Article 7. ―Business Profits. where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein. Id. at 6.133 4. A subsidiary may create a PE for its parent only if the premises of the subsidiary are at the disposal of the parent and that constitutes a fixed place of business through which the parent carries on its business. Id. .132 3.1.135 IV. at 26-27. 7. at 6. ¶ 41. or the subsidiary acts as an agent of the parent. Id. Id. 2. the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment. ¶ 41. Participation by a local group company in negotiations between a foreign enterprise and a local client does not by itself create an Agency PE—. the former company does not constitute a PE of the latter company.

oecd. Where profits include items of income which are dealt with separately in other Articles of this Convention. COMMENTARY ON ARTICLE 5. 4. the method of apportionment adopted shall. CTR. ¶ 1. there shall be allowed as deductions expenses which are incurred for the purposes of the permanent establishment. .144 THE GLOBAL BUSINESS LAW REVIEW [Vol. 138 Another important tenet is that ―the taxation right of the State where the [PE] is situated does not extend to profits that the enterprise may derive from that State but that are not attributable to the permanent establishment. ¶ 42. 137 138 139 Id. interest and royalties arising from sources in [the country‘s] territory was fully taxable by them if the beneficiary had a permanent establishment therein. In determining the profits of a permanent establishment. 6. 2:125 double taxation conventions: ―profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. whether in the State in which the permanent establishment is situated or elsewhere. Id. 5.. at 113. Insofar as it has been customary in a Contracting State to determine the profits to be attributed to a permanent establishment on the basis of an apportionment of the total profits of the enterprise to its various parts. ATTRIBUTION OF PROFITS]. ¶ 10. it should not properly be regarded as participating in the economic life of that other State to such an extent that it comes within the jurisdiction of that other State‘s taxing rights. For the purposes of the preceding paragraphs.‖ 139 Several countries have adopted what is known as the principle of general ―force of attraction‖ by which ―income such as other business profits.org/dataoecd/20/36/41031455. REPORT ON THE ATTRIBUTION OF PROFITS TO PERMANENT ESTABLISHMENTS. FOR TAX POL'Y & ADMIN. be such that the result shall be in accordance with the principles contained in this Article. supra note 7. then the provisions of those Articles shall not be affected by the provisions of this Article. at 26. the profits to be attributed to the permanent establishment shall be determined by the same method year by year unless there is good and sufficient reason to the contrary. however. even though such income was clearly not attributable to that permanent establishment. 7.11. 7. No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise. including executive and general administrative expenses so incurred.‖ 140 3.pdf [hereinafter OECD. at 248 (July 17. OECD. 2008) available at http://www. dividends.‖ 137 In the absence of a PE in another State. 140 Id. nothing in paragraph 2 shall preclude that Contracting State from determining the profits to be taxed by such an apportionment as may be customary. art.

at 67-68. available at http://www. after the profits are assigned to the dependent agent under general transfer pricing principals. THE TAXATION OF PERMANENT ESTABLISHMENTS See OECD.148 If the dependent agent is a legal entity and a taxpayer itself. 2010).oecd. ¶ 268.keepeek.pdf.149 OECD. 145 Id. where the PE is treated as an entity distinct from its overseas parent for several purposes.146 In this sense. OECD Model Tax Convention: 50 Years Young . 141 Avoiding the force of attraction approach is important and possibly of immediate application for the international tax practitioner in many countries. 2009). J.. risks assumed and assets used. 148 149 OECD.com/assets/Dcom-Belgium/Local%20Assets/ Documents/Quarterly-Jan09.. 9. See also K. PeschkeKoedt. FOR TAX POL'Y & ADMIN. Attribution of Profits—A “Separate Entity” Approach. ATTRIBUTION OF PROFITS. 147 146 AND TAX See OECD.144 According to such approach. ATTRIBUTION OF PROFITS. mean that additional taxes are owed to the country where the PE is located.143 The 2008 OECD ―Report on the Attribution of Income to Permanent Establishments‖ adopts a ―functionally separate entity‖ approach. Sekar. issues arise as to whether. INT‘L TAX‘N (Dec.2012] PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS 145 The amended OECD Commentary makes it clear that the general force of attraction approach has now been rejected in international tax treaty practice. REVISED DISCUSSION DRAFT OF A NEW ARTICLE 7 OF THE OECD MODEL TAX CONVENTION 8 (Nov. 16 TAX NOTES INT‘L 1601 (1998). available at http://www.J BURGERS (2008).‖145 Thus. available at http://www. See id.. The “Functionally Separate Entity” Approach The mere existence of a PE does not. at 67. TRANSFER PRICING GUIDELINES FOR MULTINATIONAL ENTERPRISES ADMINISTRATIONS (2010) [hereinafter TRANSFER PRICING GUIDELINES]. under transfer pricing rules. 147 This functionally separate entity approach applies even if the PE is a dependent agent PE. TAX Q. 2009-Jan. ¶ 15.J. REVISED COMMENTARY ON ARTICLE 7 OF THE OECD MODEL TAX CONVENTION. OECD. supra note 139. 142 A. ―the profits to be attributed to the PE are the profits that the PE would have earned at arm‘s length as if it were a ‗distinct and separate‘ enterprise performing the same or similar functions under the same or similar conditions. CTR.pdf. 144 142 141 ET AL. 11 (Jan.R. determined by applying the arm‘s length principle under Article 7(2). to a PE. ¶ 270.deloitte. at 25. by itself. 35 DELOITTE BELG.com/Digital-AssetManagement/oecd/taxation/model-tax-convention-on-income-and-on-capital-condensedversion-2010_mtc_cond-2010-en [hereinafter COMMENTARY ON ARTICLE 7]. 21.org/dataoecd/30/52/44104593. . there would remain any profits attributed to the PE. at 134 (July 2010). 2007). See also L. A Practical Approach to Permanent Establishment Issues in a Multinational Enterprise. 24. the OECD‘s ―Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations‖ will also be used as guidance to determine the profits attributable. the OECD MC Commentary provides that the profits attributable to a PE should be determined by reference to the PE‘s functions performed. supra note 139. at 25. ¶ 69. 143 See generally I.

11-42. at 3.org/dataoecd/20/34/41032078. ¶¶ 42. 2006). THE SERVICE PERMANENT ESTABLISHMENT RULE In 2008 the taxation of services was added to the Commentary155 in accordance with a report released as a public discussion draft in 2006. at 68. Nonetheless. 157 See Albin.157 Thus. Income and the Assumption of Risk The deciding factor on how to assign income to a PE in these circumstances relates to assumption of risks. See generally International Transfer Pricing. CTR. 150 B. See generally TRANSFER PRICING GUIDELINES. COMMENTARY ON ARTICLE 5. available at http://www. supra note 7. to equally tax profits from services and other business activities.pwc.pdf [hereinafter OECD 2008 UPDATE]. at 135. see OECD. supra note 36. OECD 2008 MODEL CONVENTION. FOR TAX POL'Y & ADMIN. ¶ 42.org/dataoecd/2/20/37811491. THE 2008 UPDATE TO THE OECD MODEL TAX CONVENTION 9-17. 2:125 The OECD has provided guidance suggesting that under some circumstances there might be additional profits to be attributed to the PE in this case. supra note 112. the dependent agent performed the significant people functions relevant to the management of those risks (e. supra note 146. available at http://www. transfer pricing rules dictate that a taxpayer should earn income as return commensurate with the risks it assumes. at 100-10. available at http://www. CTR. when a taxpayer has a PE.pdf.oecd. .11. 153 For example. ¶ 20. it gives rise to difficulties when attributing and calculating the income generated through the PE. 156 See generally OECD. at 113. and only if. 156 The previous Commentary Article 5 barred the option of a Source State taxing the profits received from the delivery of services in their territory. See OECD. supra note 147..com/en_GX/gx/international-transfer-pricing/assets/itp-2011. ¶¶ 42.48. at 19. 152 The OECD states that risk must be assigned to a PE based on functions. complicating even more the application of transfer pricing rules when directed at permanent establishments‘ profits. there can be no intercompany contract between the taxpayer and the PE allocating risks. the OECD approach would attribute credit risk and inventory risk to a dependent agent PE if. 8.pdf.11-42.oecd. Outside the PE context.154 This seems like a highly technical issue with which it would be nearly impossible for an unsophisticated taxpayer to comply. ¶ 271. a subsidiary can be stripped of all business risk by contract. running an accounts receivable department or operating a warehouse)..146 THE GLOBAL BUSINESS LAW REVIEW [Vol. 153 154 155 COMMENTARY ON ARTICLE 7.48 (2008). FOR TAX POL'Y & ADMIN. PRICEWATERHOUSECOOPERS (2011).. supra note 139.g.151 For instance. ATTRIBUTION OF PROFITS. resulting in the subsidiary being entitled to a lower overall return. THE TAX TREATY TREATMENT OF SERVICES: PROPOSED COMMENTARY CHANGES (Dec. some States voiced their wish that Article 5 be 150 151 152 Id. For a review of the changes made to the Article 5 Commentary. V.

¶ 12. at 101-02. COMMENTARY ON ARTICLE 5. 2915 of 2007 (arising out of S. Morgan Stanley and Changes in the OECD Commentaries This modification in the OECD Commentaries came right after an Indian case involving Morgan Stanley & Co.S. (C) No. new and specific rules for a characterization of a ―Service PE‖ were created. 162 It outsourced a wide range of its support services to its group company. was involved in the rendering of financial advisory services. supra note 7. DIT Mumbai v. at 115. at 114. COMMENTARY ON ARTICLE 5. and the underwriting of securities. Morgan Stanley U. at 100-10. at 101. See also OECD 2008 MODEL CONVENTION. 161 DIT (Int‘l Tax‘n). the fixed place of business requirement existing for PEs under Article 5. supra note 112.18.2012] PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS 147 changed to allow a Source State the right to tax profits from services even if they were not ascribed to a PE in that State. .13-42. at 101-02. providing services usually does not involve acting as an agent.L. ¶ 42. Id. ¶ 42. and that Morgan Stanley U.S. was not considered to be carrying on business in India.14. decided by the Supreme Court of India in 2007. at 113-123. supra note 7.160 Therefore. without doing so through a physical or project PE. ¶ 9. 162 163 164 165 166 167 160 159 See id. Morgan Stanley Advantage Services Private Limited (Morgan Stanley India). Morgan Stanley and Co. evidently. did not have a PE in India.164 This was on the basis that Morgan Stanley India was not considered to be a fixed place of business. ¶¶ 42. (C) No.18. 163 The Indian Authority held it for Advanced Ruling that Morgan Stanley U. 159 To the extent there is a physical PE. COMMENTARY ON ARTICLE 5. little service income will be attributable to that PE. under the revision of the OECD's 2008 Model Tax Convention. 165 In addition. 12907 of 2006) and Civil Appeal No.18.14. See OECD 2008 MODEL CONVENTION.L. Morgan Stanley U.11-42. See id. A. ¶ 42. See generally id. 161 In this case. 167 158 Id. supra note 112. See generally OECD 2008 MODEL CONVENTION. (2007) Civil Appeal No.166 Since some service businesses do not require a fixed place in their territory in order to carry on a substantial level of their activities therein. See OECD 2008 MODEL CONVENTION. 16163 of 2006). supra note 7.P.11-42.158 Under the current PE definition.. ¶ 42. service income will not give rise to substantial tax liability unless an additional type of PE is included in the PE definition.48.S. at 115. usually will not be taxed in the other state.P. ¶ 3. corporate lending. ¶¶ 42. supra note 7.13-42. Mumbai v. a resident of one State engaged in an extensive provision of services within the other state. See id.18.S. 2914 of 2007 (arising out of S. supra note 112. ¶ 42. could not be duly applied to services. supra note 112. COMMENTARY ON ARTICLE 5.S.48. ¶¶ 33-35. For that reason. ¶¶ 42. would not have been considered to have an Indian PE due to the fact that Morgan Stanley India did not have the ability to conclude contracts on behalf of Morgan Stanley U.

11. 171 Permanent Establishment is Key to OECD Revisions. the Business and Industry Advisory Committee to the OECD (BIAC)170 said that those proposed rules and conditions were created to help countries that wanted to ―put a special deemed permanent establishment threshold for services taxation in their tax treaties.173 Thus.com/Article/1945259/Permanent-establishment-is-key-to-OE CD-revisions.23(a).23(a). at 211. biac. COMMENTARY ON ARTICLE 5. ¶ 42. supra note 91129. at 11. ¶ 42.com/DigitalAsset-Management/oecd/taxation/model-tax-convention-on-income-and-on-capitalcondensed-version-2010_mtc_cond-2010-en. at 102. 2:125 According to such rules. Therefore.‖172 There is no need to diverge from usual PE concepts and requirements. the period for residency or for any kind of endeavor OECD 2008 MODEL CONVENTION. ¶ 42.keepeek.23(a). (June 12. the overall period shall be counted based on the total number of days the services are rendered in the other Contracting State upon effectiveness of the service agreement. ¶ 42. including the provision of independent services.169 In this regard. supra note 7. ―be treated the same way as other business activities and. ¶ 5. at 102-03. ¶ 42. at 115. the same permanent establishment threshold of taxation should apply to all business activities. OECD 2008 UPDATE. OECD 2008 UPDATE. ¶ 42.148 THE GLOBAL BUSINESS LAW REVIEW [Vol.23(a). at 252 (July 2010). therefore.org/ (last visited Jan. 169 OECD 2008 MODEL CONVENTION.tpweek. supra note 112.html. and more than 50 percent of the gross business revenues of the enterprise consists of income derived from the services performed in that State by the individual. OECD. COMMITTEE ON FISCAL AFFAIRS. Calculating Aggregate Periods for Service PEs For purposes of calculating the aggregate period of 183 days for the application of the Service PE rule. supra note 7.23(b). at 115. 168 The Business and Industry Advisory Committee to the OECD. as long as they fit the service‘s nature. available at http://www. supra note 155. a permanent establishment is deemed established in the Contracting State. all mentioned and maintained in Article 5 of the OECD MC). a Service PE may exist where services are provided in that other Contracting State for 183 days or more in any 12-month period. 173 170 ON See OECD 2008 MODEL CONVENTION. COMMENTARY ON ARTICLE 5. 26. supra note 112.‖168 In the alternative. INT‘L TAX REV. 172 OECD 2008 MODEL CONVENTION. supra note 7. 2008). 2012). at 113. at 11. ¶ 42.‖ but the new rules ―did not justify moving away from the OECD‘s fundamental principles on PE already in the model convention‖171 (i. as a general rule. B. the provision of Services PE should. supra note 155. and the activities are performed for a project or set of connected projects for customers who are either residents of that other State or who maintain a permanent establishment providing such services in that other State.11.23(a).e.. available at http://www. this is known as a ―Service PE. COMMENTARY ARTICLE 5. COMMENTARY ON ARTICLE 15 CONCERNING THE TAXATION OF INCOME FROM EMPLOYMENT. ¶ 5. supra note 112. if a non-resident entity provides services within the other Contracting State for a period of 183 days or more within a 12-month period. available at http://www. . classical requirements and the negative and positive example list. ¶ 42. at 100.

in the event there is an automatic renewal or continuance of the same service agreement. . the crucial point is to avoid defining under the Service PE clause if there is a PE in that case. C. It is important where the services are performed. it may be difficult to determine the percentage of the entity‘s gross revenue derived from the services performed by a particular individual[. Current Service Permanent Establishment Language and Issues The current wording of the Service PE clause has thus been summarized by practitioner Tiiu Albin as follows: 1. supra note 112. The amount of gross revenue is determined on the basis of the domestic laws of the Contracting States. ¶ 42. Albin.] 176 The Service PE rules will continually give rise to more discussions regarding the source tax rules and. some scholars say that the Service PEs have been introduced to the OECD MC to compensate for the deletion of Article 14 of the MC in 2000. 2. Id.‖177 One of the main problems currently facing the Service PEs is the conflict on qualification of the income derived from employees on a company that may be regarded as having a PE in the Source State. 3. and when part of the compensation is paid directly from the client in the Source State. at 4-5. some double taxation may occur.175 which is a reasonable justification. COMMENTARY note 7. at 5. Also. is not mentioned or even slightly resolved by the Model Convention or the Commentaries. Id. ―current wording may create uncertainty to taxpayers. due to the fact that its employees meet the requirements stated in that type of provision or particular treaty.14. at 120-21. 174 ON ARTICLE 5.2012] PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS 149 not connected with the services to be rendered shall not form part of the reckoning period.41. and it definitely should be addressed in the near future. not where the services are consumed or used. Precisely for that reason. [giving] looser rules to tax authorities[. The number of contracts or clients is irrelevant. according to some. In situations other than one-man enterprises. at 5. supra 175 176 177 See OECD 2008 MODEL CONVENTION. 174 Moreover. considering that an artificial entity cannot act without the people representing it. supra note 36. 4. A PE is deemed to exist irrespective of the short duration of business activities.] and can greatly increase the compliance and administrative burden of both the taxpayers and tax authorities. because it has not been specified in the Articles of DTCs. it is preferred that the personnel and employees are classified as the ones rendering services. When the source of the income is a third country. it shall be regarded as being the same or connected project for the purpose of counting the aggregate period of 183 days. however. ¶ 42. 5. This issue. at 107.

INTER-LAWYER (2002). . at 22. . In fact. CLARIFICATION ON THE APPLICATION OF THE PERMANENT ESTABLISHMENT DEFINITION IN E-COMMERCE: CHANGES TO THE COMMENTARY ON . with the progressive evolvement of e-commerce.1 and 42. despite it being difficult or even impossible to trace the location from which e-commerce transactions are performed. which have subsequently been regularly discussed and adopted by the Committee to the Commentaries to the OECD MC. The Challenge of E-commerce to the Definition of a Permanent Establishment: The OECD‟s Response. There is no physical location to which the Source State may be able to impute the income and. it gets extremely difficult to determine where such location is when business is carried out only by electronic means. technological progress and. physical location for the business to operate. Jean-Philippe.‖182 Furthermore. the Internet became a real challenge to such international principles as originally written. COMMITTEE ON FISCAL AFFAIRS.180 TAG has specifically identified that. available at http://www. . E-COMMERCE AND PERMANENT ESTABLISHMENTS [Vol. on the other hand. avoids potential qualification of the enterprise as a PE. supra note 37. at 3. no PE could be considered to exist in those cases. and (c) have websites hosted by Internet Service Providers (ISPs). the OECD Committee on Fiscal Affairs (―the Committee‖) set up the Technical Advisory Group on Monitoring the Application of Existing Treaty Norms for Taxing Business Profits (TAG). Considering this emerging problem. OECD. Because of electronic commerce (e-commerce). thus. 179 180 181 182 178 See CURRENT TREATY RULES. in itself.inter-lawyer. such traditional views of this concept have been greatly destabilized. Id. 178 The Internet constantly becomes a tool to manage business without the need of a physical interface in the source country and.com/lex-e-scripta/articles/e-commerce-pe. It became apparent that the concept of PEs was designed in an almost moldable approach that enables it to fit any kind of business reality. The Committee reached a similar conclusion. paragraphs 42. accordingly.htm. the rights of taxation of a Source State over the income derived by a non-resident. although the concept of PE was traditionally directed towards the requirement of physical presence. unavoidably. ¶ 76. if we recognize that one fundamental element of existence for a PE is the necessity of a geographical. fairly easy to: (a) pinpoint a server in a low-tax jurisdiction. at 1. clearly expressing its views by stating that ―a web site cannot. it is. and at the same time physical intermediation has disappeared in this specific type of business. (b) divide business functions related to a commercial transaction between separate servers.181 In this sense. almost no physical contact is made between the consumer in one country and the seller located in another country. constitute a permanent establishment .179 an entity that has been providing for the basic standard technical reflection on the topics governing the taxation of e-commerce activities.2 of the Article 5 Commentary have been added to OECD MC in order to further confirm its position. See generally id.150 THE GLOBAL BUSINESS LAW REVIEW VI. in January 1999.183 See Chetcuti. 2:125 Although the concept of PEs had been constructed as an answer to the need for quantitative criteria to determine. under a demand for certainty and predictability.

188 OECD 2008 MODEL CONVENTION. at 97-98. 42. it is necessary to make distinctions between computer equipment located in a jurisdiction and the data and software used by that equipment.4. at 110-11. supra note 7. divergence has occurred when experts analyze the role of web servers as a sufficient physical manifestation of an enterprise ―place of business‖ for purposes of rendering applicable the concept of PE. COMMENTARY ON ARTICLE 5. something that can only be decided on a case-by-case analysis. supra note 112. the Australian Taxation Office has stated that ―place of business‖ should be determined by looking to the functions performed at that place. 184 See generally OECD 2008 MODEL CONVENTION. ¶ 42. ¶ 42. ¶¶ 42. at 97. Consequently.2012] PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS 151 After several discussions concerning e-commerce and the characterization of permanent establishments.10. at 110. ¶ 42. COMMENTARY note 7. ―the issue whether computer equipment at a given location constitutes a permanent establishment will depend on whether the functions [already] performed through that equipment exceed the preparatory or auxiliary threshold. Id. ¶ 42.1-42. 192 However. ¶ 42. Electronic Commerce Project Team. OECD 2008 MODEL CONVENTION.‖193 Examples of functions going THE MODEL TAX CLARIFICATION]. supra OECD 2008 MODEL CONVENTION. at 97. at 111.184 The presence of computer equipment at a fixed location may itself give rise to a PE in that jurisdiction.4. at 110. ¶ 42. COMMENTARY ON ARTICLE 5. at 97.1-42.2. OECD 2008 MODEL CONVENTION.2. 192 193 See generally OECD. ¶¶ 42. 188 Commonly. at 110. supra note 182. . the place where it is deposited along with the server may constitute a place of business. ¶ 42. it was decided that.2. ¶ 14.2. at 3 (Dec. at 5-7. ¶¶ 42.3. the server may not be a fixed place of business of the enterprise carrying on the business.191 Despite the overall consensus reached on the topic of non-qualification of websites as PEs. COMMENTARY note 7. at 110.185 However. 187 The server. ¶ 42. at 97-98. supra note 7.2.1-42. supra note 7. supra note 112. supra note 112. at 4. supra note 112. supra note 112. at 97. at 98.1-42. ¶ 42. at 97. ON ARTICLE 5.4. ¶¶ 14. COMMENTARY ON ARTICLE 5. 187 186 ON See OECD 2008 MODEL CONVENTION. supra note 7.2.2. 22. the company that runs a server will not be the company that carries on business through the website found on the server. ¶ 6. supra note 7. Tax and the Internet: Second Report (1999). CLARIFICATION. supra note 7. would comprise a fixed piece of equipment and be located at a specific location. at 97-98. ¶ 42.4. 183 CONVENTION ON ARTICLE 5. supra 190 See OECD 2008 MODEL CONVENTION. at 110-11. though. COMMENTARY ARTICLE 5. 189 Here. the website should not constitute a PE of the organization. although a server as such cannot be a PE itself. ¶ 42.3. 185 See OECD 2008 MODEL CONVENTION.2-42. at 110-11. supra note 112. 191 Australian Taxation Office. 189 ON ON ARTICLE 5. COMMENTARY ON ARTICLE 5. 2000) [hereinafter OECD. supra note 112.3. 190 In regard to such matter.2.186 A website would not have a fixed place of business and thus would not be considered a PE under the existing definition. as expressed by the Committee. ¶¶ 42.3. supra note 112. COMMENTARY ARTICLE 5. ¶ 42.

9.9.194 Although most States have been dealing with the problem by going around the concept of PE as it is—strict requirement of geographical presence—countries like Portugal and Spain do not consider tangibility a necessary requirement for a PE to exist in the context of e-commerce. for that reason. CLARIFICATION. controlling. Website hosting facilities should not produce PEs for the entity carrying on business through the website.198 The agreement seems to be that a server may only constitute a PE when the automatic functions carried out by such equipment had been set up by the principal enterprise and continued to be operated. 2:125 beyond mere preparatory or auxiliary computer equipment performance have been included in paragraph 42. supra note 36. supra note 182. operating. COMMENTARY ON ARTICLE 5. 195 196 197 198 199 OECD. ¶ 10. Websites do not constitute PEs. supra note 7. 2011. paragraph 10 of the Commentary to Article 5 expressly recognizes that the business of an enterprise may be carried on through automatic equipment. controlled and maintained by the same principal enterprise. Albin. INTERPRETATION AND APPLICATION OF ARTICLE 5 (PERMANENT ESTABLISHMENT) OF THE OECD MODEL TAX CONVENTION: PUBLIC . ¶ 10. ¶ 6. the subject is far from resolution when it comes to PEs under e-commerce specifications. See COMMENTARY ON ARTICLE 5. at 99. Internet service providers (ISPs) should not represent an agency position and give rise to a PE. 2. Additionally.9 of the Commentary to Article 5. at 3.197 In spite of the fact that discussions on this subject are far from being finished. the OECD published the ―Interpretation and Application of Article 5 (Permanent Establishment) of the OECD Model Tax Convention ‖ public discussion draft (OECD 2011 PE Draft).. to setting up. an enterprise carrying on business in these States through a website could be treated as having a PE in those States. In effect this level of activity by the principal enterprise assured the character of permanence. the consensus reached by the OECD with respect to determining whether a PE exists for e-commerce entities can be summarized) as follows: 1. supra note 112. VII.152 THE GLOBAL BUSINESS LAW REVIEW [Vol. THE OECD‘S RECENT PROPOSED CHANGES TO THE PE COMMENTARY: OCTOBER 12. However. at 97-98.199 which includes proposals for additions 194 See OECD 2008 MODEL CONVENTION. at 112. and 4. at 98. ¶ 42. Servers located in a jurisdiction for a suitably long period may be considered ―fixed‖ and comprise a PE.195 and. OECD CTR. with the activities of the enterprise‘s personnel being restricted. FOR TAX POL‘Y AND ADMIN. 2011 DISCUSSION DRAFT On October 12. 3. at 6. ¶ 42. Id. supra note 7. 196 The same paragraph further announces that a PE can exist where the business of the enterprise is carried on through automated equipment. and maintaining the equipment.

(4) the presence of foreign enterprise personnel (i. seconded employees).204 It is possible to sense some tension from the recommendations.2012] PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS 153 and modifications to the Commentary on the OECD Model Tax Convention following the recommendations of the Committee of Fiscal Affairs‘ Working Party 1 on Tax Conventions and Related Questions.en_2649_33747_48836787_1_1_ 1_1.S.oecd.205 A. both from prior OECD work (such as business restructuring and attribution of profits) and new inputs. the objective being to include the conclusions of the discussion in the 2014 OECD Commentaries update. and the way to include the diversity of views among OECD member countries on the other. and (6) the ―in the name of‖ expression (commissionaire arrangements).2. 2012. with the Annex consolidating all the proposed changes for paragraphs 1 through 35. and James Tobin. OECD Releases A Discussion Draft on the Definition of “Permanent Establishment” in the OECD Model Tax Convention. The “At the Disposal of” Expression Under the current Article 5 Commentary.C. especially regarding the desirability of bright line rules on one hand.oecd. following the current Article 5 Commentary. 200 The proposed alterations appear in numerical order. Based on the 2012 International Fiscal Association U. 12.org/ dman/Document. 12. 2012). 200 OECD Ctr.206 The OECD 2011 PE Draft suggests modifications to the current OECD Commentary.org/document/51/0. see http://www..pdf [hereinafter OECD 2011 PE DRAFT]. OECD.‖ which included speakers Mary Bennett. supra note 199.S.00. Branch of the International Fiscal Association (IFA).262& cmd=download.e. 2011-Feb. held in Washington. See generally OECD 2011 PE DRAFT.ORG (Oct.. the most important issues dealt with in the public discussion draft were: (1) the ―at the disposal of‖ expression. it also concludes that some changes are not necessary for others. at 93.3746.html.203 Although the discussion draft recommends several changes to the Commentary on Article 5. provided other requirements are met.A. The author‘s opinions described here are based upon many of the findings of this panel. See generally id. the place of business once ―at the disposal of‖ a foreign enterprise may give rise to a PE. 201 202 203 204 205 Id. 10. (3) time requirements. See id. supra note 7. explaining that the concept of whether a location is at the disposal of DISCUSSION DRAFT (Oct. Branch Annual meeting panel.phx/Events/%5Eeman. (2) ―converted‖ local entities (contract manufacturing arrangements). 201 The deadline for public comments was February 10. (5) main contractors who subcontract all aspects of a project. 202 There were 25 issues identified in the OECD 2011 PE Draft. on March 1-2. . ¶ 4. held a panel entitled ―Treaty Developments: Permanent Establishments and Beneficial Owners – The Search for Meaning.ifausa.262/Agenda+Package+-+Technical+Program?folderId =Events%2F%255Eeman. for Tax Pol‘y and Admin. For a compilation of this event‘s speakers and presentations. http://www. 2011). available at http://www. Jesse Eggert. Rocco Femia.org/dataoecd/ 23/7/48836726. The 40th Annual Conference of the U. D. 206 See COMMENTARY ON ARTICLE 5.

due to contractual obligation.154 THE GLOBAL BUSINESS LAW REVIEW [Vol. all property will be owned by CARCO. . Id. 212 213 214 See id. at 8-10. According to the ―CARCO‖ example. at 45. Id. 213 The ―CARCO‖ example was used to illustrate this concern. Peter provides training in staff offices and is permitted to use 10 rooms for group training or to prepare its courses. supra note 199. leading to the conclusion that the premises of such converted local entity are ―at the disposal‖ of the foreign enterprise or that the business of the foreign enterprise is being carried on on those premises. the discussion draft includes an example (the ―CLIENTCO‖ example) and debate over whether there is a PE under those hypothetical facts. Id. at 9.‖ 207 and (2) ―the activities that it performs there. The parts will be physically sent to SUBCAR. 2:125 such foreign enterprise may vary upon two conditions: (1) ―the extent of the presence of an enterprise at that location. the discussion draft generally concludes that the premises of the converted entity are not at the disposal of the foreign enterprise. based on two findings: (1) availability of training rooms for preparation. ¶ 4. In the CLIENTCO example. 209 The premises are not considered to be ―at the disposal of‖ a foreign enterprise where an enterprise‘s presence at a location is so intermittent or incidental that th e location cannot be considered its place of business. at 9. After analyzing this factual pattern. However. CARCO sets up a SUBCAR in State S to assemble cars from parts owned and supplied by CARCO. SUBCAR‘s plant will be built by CARCO for manufacturing IP and SUBCAR will retain a cost plus margin for its functions. OECD 2011 PE DRAFT. and (2) training was a ―core part‖ of the business of the consultant. at 11-12.2. Peter is required to use CLIENTCO facilities. The conclusion of the OECD Working Group was that CARCO does not have a PE in State S. based on the following findings: (1) the premises of SUBCAR were not used by CARCO and were not at its disposal. at 11. supra note 199. ¶ 4.‖208 The premises are considered ―at the disposal‖ of a foreign enterprise if there is exclusive legal rights to use the location only for carrying on business of the enterprise. Id. Id. “Converted” Local Entities Another issue concerns the possibility of performance of activities by a ―converted‖ local entity for foreign enterprise. or if there is a performance of business activities by the enterprise on a continuous and regular basis during an extended period of time.2.211 B. due to business restructurings. 210 In order to make the recommendations clearer. the members of the OECD group who expressed a view concluded that premises were at the disposal of Peter (the consultant). and suggests the inclusion of a new sentence in the current Commentary in order to clarify this particular issue. 212 In such case. or where an enterprise does not have a right to be present at the location and does not use that location itself. Peter is given a security card allowing access to premises during business hours. the facts are the following: Peter (the consultant) provides training to CLIENTCO staff over 20 months.214 207 208 209 210 211 OECD 2011 PE DRAFT. at 10. ¶ 4. See generally id. and the cars back to CARCO. (2) no agency PE existed since SUBCAR did not exercise any authority to conclude contracts in the name of CARCO.2.

Id. Id. 222 and (2) inclusion of additional language in the context of duration of construction sites. supra note 7. 215 216 217 218 219 220 221 222 223 COMMENTARY ON ARTICLE 5. at 20-21. at 95. supra note 199.215 The same Commentary observes that. OECD 2011 PE DRAFT. Id. 220 An additional topic of concern relates to main contractors who subcontract all aspects of a project. Id. and (2) short duration of business. where each period of time that the place is used is considered in the aggregate. the question being whether this action would lead to the foreign enterprise having a permanent establishment if it subcontracts all aspects of the project to other enterprises. Id. 219 The matter herein includes reference to the background discussions to Article 15 standards.1. 216 The OECD 2011 PE Draft recommends some minor changes to the Commentary.2012] PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS C.e. at 21. The Presence of Foreign Enterprise Personnel Another important issue debated in the discussion draft relates to possible changes in the Commentary in order to clarify that employees of a foreign enterprise seconded to an affiliate generally are considered to carry on the business of the affiliate and not of the foreign enterprise. being added with the other number of times during which the place is used. mainly characterizing the six month rule as a ―general practice‖ and providing examples for each of the two exceptions previously mentioned to facilitate the identification of these specific cases. except in case of: (1) recurring activities. a place of business maintained for less than six months is not commonly a PE. ¶ 19. Time Requirements 155 In regard to the time requirements related to PE characterization. empirically. at 20. 217 D. 218 This understanding seems to be applicable even if formal secondment is not in place (i. where activities constitute an entire business carried on exclusively in the Source State. at 16-17. ¶ 10. 223 The example of a small hotel. including the cases where the employee is in substance an employee of the affiliate). Id. 221 There were two proposed sets of changes made in the discussion draft: (1) adoption of new language in the context of general rules suggesting that a foreign enterprise may be considered to carry on its business through subcontractors even where such subcontractors act alone. . the current OECD Commentary provides that a place of business may constitute a PE even if it exists for a short period of time. stating that the site should be considered at the disposal of the general contractor during the time spent by any subcontractor. Id. ¶¶ 6.. ¶ 10. in and (3) the analysis remains the same notwithstanding if the arrangement was a result of a business restructuring or not. at 18. at 21.2. Id. ¶ 6.1-6.

at 105. proposes the inclusion of an additional sentence to the Commentary.1..-s. Id. Societé Zimmer Ltd. having decided that no dependent agent PE existed in either case because the enterprise was not legally bound. was also addressed in the OECD 2011 PE Draft. 225 Currently. CONCLUSION The concept of a PE is fundamental in international taxation. For that reason. it is not clear if the term ―bound‖ means only ―legally‖ bound or ―economically‖ bound (i. each of them dealing with a commissionaire. the Working Group stated that it could not reach a common conclusion on situations dealt with in the recent cases Societé Zimmer Ltd. at 35-37. 2. in 13 INT‘L TAX LAW REP. at 36.224 E. noting that in some countries a foreign enterprise would be bound to a contract concluded with a third party by a person acting on behalf of the enterprise even if the person did not formally disclose that it was acting for the enterprise and the name of the enterprise was not referred to in the contract.156 THE GLOBAL BUSINESS LAW REVIEW [Vol. Mar. at 21-22.229 (France) or Dell Products (NUF) v. 231 232 OECD 2011 PE DRAFT. n° 304715. 10e et 9e s. in which a foreign enterprise agrees to reimburse the commissionaire for any amount due on its contractual liabilities to customers (an ―economically bound enterprise‖).1. ¶ 32. ¶ 33. 308525. It is this concept that determines the right of a contracting state to tax the profits of an enterprise in another jurisdiction. 706. Id. COMMENTARY ON ARTICLE 5. at 36-37. Tax East: 10-032855ASD-BORG/03. Id. 231 However. 2011).227 Additionally.. however. 2:125 which the owner of the hotel has a PE even though on-site operation of the hotel is subcontracted to another company. 2010.‖226 The discussion draft. 706-746 (London 2011) (posterior decision of the Supreme Court of Norway rendered Dec.228 As for this example. Conseil d'Etat [CE] [Supreme Tax Court] Paris. supra note 7. 232 VIII. the characterization of permanent establishment is one of the most difficult and complex issues in international business taxation. supra note 199. through a contract between an enterprise and commissionaire). illustrates the main idea.e. at 38. Also. ¶ 32. the discussion draft mentions the commissionaire example. supra note 199. there is an increasing need to clarify and 224 225 226 227 228 229 Id. . It is understandable that companies operating in several parts of the world would want to avoid double taxation. the Commentary provides that the standard applies to an agent who concludes contracts ―which are binding on the enterprise. 230 Dell Products (NUF) v.‖ regarding the possibility of a dependent agent constituting a PE of the principal if the dependent agent has (and habitually exercises) authority to concl ude contracts ―in the name of‖ the principal. at 35. OECD 2011 PE DRAFT. the clarification of the meaning of ―in the name of. Tax East 230 (Norway). 31. The “In the Name of” Expression Lastly.

there is a need to continually update and revise the OECD Model Tax Convention in order to ensure adherence to its purpose. The recent OECD discussion draft on interpretation and application of Article 5 is definitely an advance on common problems involving permanent establishments in the current modern economy. On the other hand. The guidance produced by the OECD. the use of a time period as a yardstick can result in difficult negotiations with foreign authorities. they will not only have more legal certainty to impose (or abdicate) taxing powers based on their own rights. 233 Indeed. It is undeniable that. the PE concept is far from being free from problems. the issues may appear to be clear-cut.S. it is vital to help taxpayers worldwide determine if they will have a taxable presence and if there might be a potential increase in their tax burden as investors. either by adding and reviewing the wording of Model Conventions such as the OECD. especially in the international taxation scenario. U. Without it.S. it is necessary that it has a ―working‖ definition. Common difficulties include determining if there is a place of business and the possibility of there being more than one. there is much more to be done. as business methodologies become more complex. 233 . as well as adapting new principles and standards for international activities carried on by foreign enterprises. U. with clearer and more updated standards. if the concept is to continue to be used. taxpayers would be operating in the dark. and UN Model Conventions must become dynamic and multi-faceted as well. Efforts to conform to the changing business practice as shown in the revisions to the OECD and UN Model Convention are certainly well appreciated.S. but do not create certainty for state actors and business interests. It may be contended that the concept does not properly reflect the present business environment. As the business environment in which we operate evolves so should the concept of PEs to reflect those social. However. the OECD 2011 PE Draft still leaves several important points out in the open.g. or by expanding the Commentaries and Technical Explanations to them on current important matters. Therefore. periodically revised and improved. earthquake or financial crisis). economic and political changes.2012] PROBLEMS INVOLVING PERMANENT ESTABLISHMENTS 157 harmonize the PE concept and requirements worldwide through tax treaties. The determination of when a project commenced may be up for considerable debate. Nevertheless. due to the In the case of construction sites. but also incentivize cross-border business. UN and U. and can be considered as a starting point in reformulating some of the rules. and UN Model Conventions is surely useful but is in no way conclusive in addressing all the crucial issues in today‘s evolving global economy. As demonstrated herein. on the one hand. When a state assists in the improvement of an internationally agreed consensus on the interpretation and application of the Article 5 PE rule. since taxpayers will be able to rely on clearer and better legal definitions in order to structure and orient their businesses worldwide.. which may result in an increased tax cost due to the inability to offset losses against taxable profits. The issues surrounding the introduction of the Service PE rule and the development of the e-commerce harmonization with PE concepts is just the start of the development. versions. thus changing to reflect current reality. which may in some cases appear as punitive rather than practical (e. With the changes in business practices of companies worldwide (every day more intangible and electronic). Commentaries on the OECD. as well as the non-exclusion of temporary discontinuations due to reasons beyond the non-residents‘ control from the total time period.

and more specifically. but still much is to be seen as to whether its developments will be suitable for today‘s economy. they cannot be used by countries to guide their treaty interpretation and application. the main contractor who subcontracts all of the project under the converted local entities. . due to the non-binding force of the discussion drafts created by OECD which are not yet Commentary but just mere reports on the debate carried out by specialists without formal approval or prescriptive organization coherence.158 THE GLOBAL BUSINESS LAW REVIEW [Vol. 2:125 difficulties of reaching a common ground on such volatile and intricate subjects as the commissionaire arrangements. For that to happen. it is necessary for the OECD and States to take their time duly debating these issues to contribute to the harmony of international taxation standards. Evolution on this subject has already started. In addition. double tax treaties. and ―at the disposal of‖ circumstances.

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